External Monetary and Financial Spillover Effects in Emerging Asia

Global economic and financial integration has increased substantially in the last three decades, reaching a high degree of interconnectedness. Accordingly, in this paper, I analyse how shifts in the monetary policy of the US, Japan, and China, as well as in financial uncertainty, affect the macro-financial stability of emerging Asia. Also, I investigate how these external spillover effects relate to country-specific characteristics during periods of crises. I conduct the analysis in a Bayesian VAR setup. My results indicate that global monetary and financial spillovers from larger countries influence developing Asian economies through fluctuations in portfolio capital flows and financial conditions. Then, such variations affect key local macro-financial variables like the exchange rate, inflation, and GDP growth. Further, I find that exchange rate stability, monetary policy independence, financial development, capital controls and macroprudential policies partly explain differences in business cycles among developing Asian countries in episodes of past crises. Based on these results, I assess the risk of capital flight in emerging Asia in the context of a stressed environment with adverse global conditions. I examine this by carrying out a series of simulations in an augmented version of the model with stochastic volatility and time-varying mean. I find that most of the developing Asian countries are confronted with potential portfolio flow reversals when external monetary and financial conditions tighten. From a policy perspective, emerging Asia could benefit from monitoring these spillover effects and from combining traditional tools with capital controls and macroprudential policies to safeguard the country’s macro-financial stability